• Cutting Back on European Debt

    Bankers want to lend money.  It’s their primary method for generating profits.  But when bankers stop lending money to specific borrowers, they are indicating their lack of confidence in the borrowers’ ability to repay the debt. 


    Nomura, one of the leading Japanese financial institutions, announced this week that it has cut its holdings of Italian debt by 83%, Spanish debt by 62%, and Greek debt by 42%.  According to the NY Times, “Nomura’s announcement is the latest sign that global confidence is waning in Europe’s response to the sovereign debt crisis” (Read the article by Mark Scott, Nov 29, 2011).


    Nomura is not alone in its risk aversion. 


    Moody’s issued a press release this week confirming the severity of the European financial crisis:


    The probability of multiple defaults (in addition to Greece's private sector involvement programme) by euro area countries is no longer negligible. In Moody's view, the longer the liquidity crisis continues, the more rapidly the probability of defaults will continue to rise.


    Discussion Questions:


    ·        What happens to the interest rate paid by these sovereign borrowers if financial institutions like Nomura refuse to lend them money?


    ·        What are current Italian interest rates?

  • U.S. Dollar Liquidity Increased by Central Banks

    The Federal Reserve and five other central banks announced this morning that they will lower the rate at which foreign financial institutions can borrow U.S. dollars. 


    The Fed press release stated:


    The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.


    According to the NY Times 30 Nov 2011:


    The central banks announced that they would slash by roughly half the cost of an existing program under which banks in foreign countries can borrow dollars from their own central banks, which in turn get those dollars from the Fed. The banks also said that loans will be available until February 2013, extending a previous endpoint of August 2012.


    Discussion Questions:


    ·        What does this action by these six central banks mean to financial markets?


    ·        Go to www.oanda.com and track the recent changes in the exchange rate of U.S. dollars to euros (EUR).  How is this action likely to affect exchange rates for USD?


  • Political Instability Leads to Economic Instability in Egypt


    The political turmoil in Egypt is having a tremendously negative economic impact.  The IMF forecasts that Egypt’s economy may slow down to 1.2% growth this year compared with 5.1% in 2010. 


    Tourism is one of the primary drivers of the Egyptian economy, accounting for 1 in 8 jobs.  Tourism has declined by 40 percent and may decline further.  The Egyptian stock index is down almost 50% this year, though trading on the stock exchange remains open. 


    Can the economy survive until the political turmoil passes?  We don’t know. The images of street violence will not be attracting investors or tourists for the time being. 


    Discussion Question:


    How would an investor evaluate political risk when considering foreign investments?


  • Next in the Eurozone: France

    In France, business owners may be optimistic this holiday season, but from a macro perspective, there may be cause for concern.  French banks face exposure to other European nations.  The French government itself has a high level of debt that it is trying to bring under control.  And finally, France faces the risk that it will be downgraded by the rating agencies.


    According to the CNN Money video above, the effect of a credit rating downgrade would be worse for France than it was for the U.S. because 75 percent of French debt is held by foreign investors. 


    What’s the solution? Some suggest bringing the unified currency under unified political control by giving the European Central Bank more authority.  This option has its opponents, but as the financial situation in Europe becomes more dire, it may become reality before too long.


    Discussion Questions


    1.    Why might unified control by the European Central Bank help the financial crisis in Europe? 


    2.    Why are some political leaders opposed to this option?


  • The Cost of a Thanksgiving Turkey

    photo courtesy of Ben Franske and licensed under GNU Free Documentation License




    An estimated 46 million turkeys will be consumed today, according to the National Turkey Federation, and they are estimated to be 22 percent more expensive than they were last year according to the American Farm Bureau (read the Bloomberg article here).  Though the cost of the birds is so much higher than last year, supermarkets do not pass on the full cost to consumers and, instead, sell turkeys as loss leaders in the hopes that shoppers will buy other groceries when they are in the stores. 


    Why are turkeys so costly? The answer is corn.   


    The average cost of corn, the primary feed ingredient, jumped 58 percent this year from 2010 and is headed for an all- time high, erasing the benefit of retail turkeys that the government says averaged $1.59 a pound this year, up 6.4 percent from last year. About 70 percent of the cost of raising each bird is feed, farmers say


    Some turkey farmers are cutting back production.  Profits are down for processors like Hormel foods.  Butterball, the largest U.S. turkey producer announced that it is closing a plant in Colorado because of the high costs. 


    We got an 18-pound fresh Butterball turkey this year for $1.69/lb.  The grocery store obviously didn’t pass on the full cost of the turkey to me.  But they knew what they were doing because we always spend more money on the ‘fixins’ than we do on the turkey itself.


    Happy Thanksgiving!    


  • Investing Advice


    Not sure how to invest your money in this environment?  Below is some timeless advice from CNN Money. 


    The main idea is to decide when you need to spend the money.  If you know you need the cash in the next few years, then safe investments like bank CDs and money market funds are a wise choice.  If you can afford to wait longer than that for the money, then you can afford to risk it in the stock and bond markets by investing in stock and bond mutual funds.


    Discussion Questions:


    1.    What financial needs do you foresee for yourself in the next year? What about 5 years? 10 years? 40 years?


    2.    What is a stock mutual fund and a bond mutual fund? What are the costs associated with investing in these mutual funds?


  • Who's Investing in Stocks?

    Mom and pop investors are put off by market volatility.  They’re sitting on the sidelines and not likely to jump back into the stock market again in any meaningful way for some time.  And yet, the stock market has seen gains this year.  So the question is this: who’s buying?


    According to this CNBC article, the buyers are the companies whose stocks appear to be undervalued.  This year marked the third highest year for stock buybacks, and that is a signal that firms believe their stock prices are too low.


    "The volatility is going to continue until we get some more progress on the policy issues related to the European debt question. There's no end of that in sight," Gendreau says. "Corporations, meanwhile, are looking at their stock prices — they're beaten down, valuations are lower than normal, and they're saying, 'Why not?'"


    For Wall Street, then, the main question is when and whether small investors will be willing to come in off the sideline and put some of the $2.64 trillion sitting in money market funds to work.


    Discussion Questions


    1.    What is a stock buyback and what does it signal about the firm’s stock value?


    2.    In your opinion, is there a difference between investors over the age of 50 and investors under the age of 30 towards investing in stocks?


  • Italy, Spain...What's Next?

    Too big to fail. 

    The argument for many years has been whether any financial institution is too big to fail.  That is, are any institutions so big that their failure would lead to system wide failure? 

    Greece, Italy, now Spain.  The question facing Europe at the moment is not whether a single financial institution is too big to fail, but whether a country is too big to fail.

    Spain's 10-year bond yield was trading at 6.37% on Friday. That's better than the 6.9% high it recently hit but it is still uncomfortably close to 7%. That was the benchmark crossed by Ireland, Greece and Portugal before they got bailed out by their eurozone neighbors.

    Italy's bond yields crossed into the danger zone last week, when yields on Italian 10-year bonds traded as high as 7.48%. That marked the first foray above 7% since the euro was launched in 1999. And it sent waves of fear across world markets, with U.S. stocks sinking more than 3%.

    It quickly raised questions about whether Italy was too big to fail. Answer: yes. It also raised questions about whether Italy was too big to bail. That answer was also yes.  (Read the full CNN Money article by Aaron Smith, Nov 18 2011 here.)

    According to Douglas Elliot, Nov 10 2011 on CNN Money:

    Italy is the domino that cannot be allowed to fall over, because it would risk knocking over too much else.

    Yet it is also so large that saving it requires huge financial resources. Italy has well over $1 trillion of government debt, about 1.2 times the annual output of the whole nation.

  • Investing in a Recession

    In this economic climate, which investments are the wisest?  According to this SmartMoney article:

    In recessions, four characteristics point to outperformance. The first: low share price relative to measures of value like earnings, sales and dividends. The second: low risk, as evidenced by limited trading volatility in the past and tightly clustered earnings estimates today. The third: high quality, defined as an ability to earn healthy profits using limited assets and debt. The fourth: size -- when times get tough, big is better.

    Warren Buffett, the legendary investor, has chosen to invest in IBM.  Let’s see if IBM, also known as “Big Blue,” meets these criteria. 

    According to this SmartMoney article:

    1.     Rather than low P/E (which is one measure of “value”), “IBM has doubled in price in five years and sells for 14 times this year's earnings forecast, on par with the broad stock market.” (Read more here)

    2.     For trading volatility, the price chart over the last three months shows volatility similar to the S&P 500.


     (source: Dow Jones & Company, Inc. http://www.smartmoney.com/quote/IBM/?story=charting)

    3.     In terms of ability to earn profits, IBM’s 5-year earnings growth is 15.73% and its projected long-term EPS growth is 10.7%.  (See more data here)

    4.     And when it comes to size, IBM is top in its class with nearly $219 billion in market capitalization and total assets of $113 billion.

    Discussion Question:

    1.     Based on this analysis, does IBM meet the four criteria outlined in the SmartMoney article?

    2.     What other reasons did Warren Buffet give for his decision to buy IBM shares?


  • The Consumer Financial Protection Bureau

    Jobs may be scarce, but the Consumer Financial Protection Bureau (CFPB) is hiring. 

    “The C.F.P.B. needs highly qualified staff, from those who are skilled in handling individual consumer complaints to experts in legislative and intergovernmental affairs to lawyers who are able to craft clear and precise rules,” Raj Date, who is leading the bureau, said in a statement. “Together with the C.F.P.B. staff already on board, these new hires will help us ensure that consumers have the information they need to make the financial choices that are best for them.”

    Read the NY Times Dealbook article here.

    The CFPB is a new agency created by the Dodd-Frank act, and its purpose is to watch for “major violations of mortgage disclosure laws and other infractions at the firms that could cause consumers to unwittingly sign up for risky loans. It also scrutinizes whether credit card forms issued by big banks are misleading” (NY Times, 16 Nov 2011). 

    Watch a speech by President Obama on financial reform here.

    Discussion Questions:

    1.      What is the purpose of the Dodd-Frank act?  What are the main provisions of the act?

    2.      What are some specific reasons that market participants resist the Dodd-Frank act? What about reasons to support the act?


  • Purchasing Power Parity--Do You Want Fries With That?

    Beijing McDonalds, photo by N. Richie

    The Big Mac Index celebrates its 25th year in 2011.  Created by the Economist magazine as a an attempt to explain the economic theory of purchasing power parity (PPP), the Big Mac Index has become a widely used measure of exchange rate equilibrium.

    PPP says that, in the long run, exchange rates should adjust to make the prices of goods (like Big Macs) the same across countries. 

    “The average price of a Big Mac in America is $4.07; in China it is only $2.27 at market exchange rates, 44% cheaper. In other words, the raw Big Mac index suggests that the yuan is undervalued by 44% against the dollar.”

    (read the full Economist article here)

    Discussion Questions:

    1.    What are some reasons why purchasing power parity as reported by the Big Mac index might not hold?

    2.    On a trade weighted basis, by how much is the Chinese yuan undervalued?  What about other currencies?


  • Voters, Place Your Bets

    Financial contracts called “futures” are used by investors to buy or sell an asset at a future settlement date.  Some contracts settle with a physical delivery while others are simply cash settled between buyer and seller, depending on who won or lost. 


    Farmers can use corn futures to guarantee a price in the future.  Airlines can use oil futures to fix prices of fuel.  Even Eddie Murphy and Dan Ackroyd used futures to bet on the price of orange juice in the 1980s movie Trading Places. 


    You can bet on the price of just about anything.  Corn, oil, OJ, even the weather. 


    Add the upcoming elections to the list of possible bets.


    Intrade is an electronic market where folks can bet on who will win the next election.  And it has been surprisingly good at picking winners.  Better than polls, in fact.


    The idea is this: Just like Wall Street, the collective wisdom of thousands of bettors with skin in the game will yield a better guess than isolated data points.


              (read the CNN Money article here)


    Discussion Questions:


    1.    How quickly do the prices of intrade futures contracts on election results react to news?


    2.    In your opinion, are these futures contracts a way of hedging or speculating? Why?


  • The Question of Italy


    Question:  What’s seven times bigger than Greece?


    Answer:  Italy.


    What does this mean to the average investor?


    If Italy can institute austerity measures, then that is good news for American jobs and American businesses.  If Italy cannot institute the austerity measures, then an Italian financial crisis is coming.  Bad news for Europe and potentially bad news for the U.S as well. as we may experience some spillover.


    In both cases, since Europe is facing recession, investors may want to look for opportunities in the U.S. and some high-quality emerging market firms.


    Discussion Questions:


    1.    In your opinion, how much confidence do investors have that Italy’s crisis can be resolved?


    2.    What impact does investor confidence have on financial markets?


  • Morgan Stanley Fined for Bond Markups

    What’s the difference between a broker and a dealer?

    It’s easy to remember.  A broker never owns the asset that is passing from buyer to seller.  Acting as agent, the broker earns a commission by bringing the two parties together.  An example is a real estate broker.  At no time during a home sale transaction does the real estate broker own the house. 

    A dealer, on the other hand, acts as principal and buys the asset at the bid price from the client.  The dealer then marks up the asset and sells it at the ask (or offer) price to another client.  An example here is a car dealer.  When a car is traded in, the dealer often buys it from the client and then sells the used car at a new price.

    Many investment banks serve as both brokers and dealers.  Recently, Morgan Stanley Smith Barney was fined by the Financial Industry RegulatoryAuthority (FINRA) for charging “higher than warranted’ markups and markdowns, as much as 13.8 percent on corporate and municipal bond deals.”  (Read the Bloomberg article here.)  Morgan Stanley cooperated fully and was ordered to “revise procedures for reviewing markups and markdowns.”

    Read the full FINRA press release here.

    Discussion Questions:

    1.     What are the benefits and limitations of a broker market versus a dealer market?

    2.    What is the function of FINRA?

  • Capital Budgeting: The New Barnes & Noble Nook Tablet


    In the market for a new tablet computer this holiday? Then the Barnes and Noble Nook tablet is competing for your business.  Priced around $249, this product is after the customers who want an e-reader, mp3 player, and tv and movie viewer.  Cheaper than the Apple iPad but more expensive than the new Kindle fire, this tablet is hoping to grab a specific segment of the market.


    For Barnes and Noble, launching this product was a classic capital budgeting decision.  Consider the forecasts that went into the decision:


    ·        What price would customers pay for the Nook tablet when the Amazon Kindle Fire would be selling for $199?

    ·        How much would it cost to produce a device with the display, memory, and apps that customers would seek?

    ·        What erosion would Barnes and Noble face in their existing line of Nook products?

    ·        Would customers buy additional products once they purchase a Nook tablet? Products like additional books, magazines, or games that they otherwise would not have purchased?

    ·        What discount rate should Barnes and Noble use to discount the expected cash flows associated with this new product?


    Discussion Questions:


    1.      What risks does Barnes & Noble face in launching this new product?


    2.      What is scenario analysis? What is sensitivity analysis? How could Barnes & Noble use these tools to evaluate their decision to launch?


  • Jefferson County Files for Bankruptcy

    Until yesterday, Orange County, CA held the title for the largest municipal bankruptcy in the U.S. at $1.6 billion dollars. Yesterday, Jefferson County, Alabama became the largest municipal bankruptcy in history with more than $4 billion in debt that it cannot repay.

    Jefferson County is the fourth bankruptcy filing this year, following the the city of Harrisburg, the capital of Pennsylvania.

    According to the CNBC report above, the bankruptcy had very little impact on bond markets in Alabama. Jefferson County bonds were already illiquid; the bankruptcy was no surprise to investors. And elsewhere in Alabama, cities and counties have been able to borrow money.

    Still, this is not welcome news in Alabama. According to CNNMoney:

    "Bankruptcy will negatively impact not only the Birmingham region, but also the entire state," Bentley said. "My administration has worked closely with the Jefferson County Commission, the sewer creditors and legislators to work toward a settlement that is in the best interests of the Jefferson County residents and rate payers."

    Discussion Questions:

    1. What are the potential negative effects of the bankruptcy on the Birmingham region and the state of Alabama?

    2. Why did bond values not react to the news of the bankruptcy?


  • Revenues Rise but Stock Price Falls

    Revenues and net income rose, but the stock price fell.  Is that right?

    Yes, that is right.  Though an increase in sales and net income should be good news for shareholders, it turns out to be bad news if the increase was less than expected. 

    Shareholders of Green Mountain Coffee Roasters are facing this same situation.  Sales increased to $711.9 million, but that was less than the $757.7 million that analysts expected.  The news caused the stock price to fall by 30 percent. 

    This is an example of the difference between expected and unexpected information affecting securities prices.  According to the Efficient Market Hypothesis (EMH), stock prices reflect all available information.  Had Green Mountain announced revenues to be as high as analysts expected, then theoretically the stock price would not have moved today.  It was the unexpected news that drove the price down. 


    Discussion Question

    According to this Bloomberg article, what other news or information may be influencing the decline in the stock price?


  • New Short Term Mutual Fund by Putnam


    Investors looking for short-term investments must choose between bank money market savings accounts, money market mutual funds, or short-term bond funds.  Savings accounts and money market mutual funds offer a guarantee of principal but interest rates that are near zero.  Bond funds, on the other hand, offer higher interest rates, but fluctuation in the value of the fund means that investors can lose their invested principal.

    Enter a new fund by Putnam Investments. 

    Offering higher interest rates than a money market mutual fund but lower volatility than a short-term bond fund, Putnam is hoping to be the, “natural choice for nervous investors whipsawed by the markets’ high volatility” (Read the article by Gil Weinrich, AdvisorOne, Nov 3).   By investing in short-term bonds as well as money market securities, the fund expects to yield 40 to 70 basis points over Treasury bills. 

    Watch an interview with Putnam's Portfolio Manager, Michael Salm here.

    Discussion Questions:

    1.     What is a money market mutual fund?

    2.     What is the net asset value (NAV) for a money market mutual fund?  How will the NAV of this new Putnam fund differ from the NAV of a traditional money market mutual fund?  What does this mean for the investor? 

    3.     Based on the article referenced above, what are the specific types of securities that this fund will be choosing? What are the distinguishing characteristics of each of these investments?


  • Let's Call the Whole Thing Off

    Greek Prime Minister, Papandreou, announced Thursday that the national referendum on the bailout would be called off.  That announcement has calmed market participants.  The euro, it seems, is safe and bankruptcy has once again been averted. 

    Papandreou’s proposal to hold a national referendum on the bailout plan, a vote that would also determine Greece’s future in the euro zone, had caused fissures within his Socialist party and sent shock waves through Europe. In Frankfurt, Germany, the European Central Bank said it would lower interest rates by a quarter percentage point, indicating deep concerns about Europe’s outlook. In Cannes, France, where leaders at the Group of 20 summit had warned they would cut off all support to Greece until the referendum was resolved, the drama dominated discussions….

    Papandreou’s plan for a national bailout referendum had effectively halted the flow of European aid to Greece and endangered the country’s participation in the euro zone. The move away from the referendum stemmed from the opposition’s new willingness to agree to a bailout, as well as intense disagreements within Papandreou’s party.

    “Greek politicians signal support for tough bailout plan” by Michael Birnbaum, Washington Post, Nov 3


    And now, though Greek participation in the euro is likely to continue, Papandreou’s term as Prime Minister might not. 


  • Raising Money to Support Anti-Greed Demonstrations

    Ironic, isn’t it?  “Occupy Wall Street has raised more than $500,000 in New York alone to support anti-greed demonstrations” (Reuters, Nov 2). 

    One question faced by the organizers is what to do with the money.  What bank should they use to hold their account? Certainly not the banks they are protesting.  They need an anti-greed bank to hold the anti-greed money.  After all, they can’t carry it around in a satchel all day.

    Society needs a well-functioning financial system.  One without fraud.  Otherwise, we’re reduced to a barter economy with no reliable payment system, no way to time our spending and savings, and no mechanism to safeguard valuables. 

    The organizers of Occupy Wall Street need a well-functioning financial system like everyone else.  They’ve chosen Amalgamated Bank, a formerly 100 percent union-owned bank.  Forty percent of Amalgamated is now owned by Wilber Ross and Ron Burkle, both of whom are among the 1%.

    Discussion Questions

    1.     What functions do financial institutions serve in the economy?

    2.     What are the benefits of well-functioning capital markets?


  • New Greek Worries

    photo of Greek flag available under Creative Commons http://www.flickr.com/photos/fdecomite/4815828849/in/set-72157623600012166/


    Greek voters are expected to vote in January on whether to accept the terms of the debt bailout.  If they reject the bailout, then Greece may default on its debt and could leave the eurozone. 


    The surprise announcement of the pending vote sent a new round of volatility to financial markets. We thought things would settle down when banks agreed to accept the 50 percent haircut on Greek debt.  And yet even then, analysts had indicated that the details had not yet been ironed out.


    One of those “minor” details is whether the Greek people themselves would agree to the plan.  No one asked them.  Well, now they’re being asked…and the answer may be a resounding “no!”


    Read more in the LA Times article.


  • Default in Derivatives Markets

    What does it take for a company to be listed on the New York Stock Exchange?  More than what MF Global can offer.  According to the news release by the NYSE,


    “NYSE Regulation has determined that the Company is no longer suitable for listing.” 


    MF Global is a derivatives broker with about $41 billion in assets.  It was forced to file for bankruptcy protection after “bad bets on Euro zone debt,” according to Reuters. Some have likened this to the failure of Lehman brothers, but because of its smaller size, the damage is more likely to be manageable.


    Yesterday, the CME group limited all trading with MF Global to liquidation trades only.  The London Metals Exchange declared MF Global a “defaulter” and suspended it from trading.  The effects of the default have rippled through derivatives markets. 


    “Trading activity in gold, crude oil and grain futures slowed to a crawl as the bankruptcy forced a chaotic scramble to untangle trading positions. … Commodities such as natural gas and crude, where MF Global had a strong presence, have been hit harder than others.”

    Read the full Reuters article and an article from Bloomberg here.

    Discussion Questions:


    1.    What are the benefits of trading derivatives on an exchange like the CME or the LME? 


    2.    What impact do you think this default will have on over-the-counter derivative markets?